Nerdy, Inc.

Good afternoon. Thank you for attending the nerdy first quarter 2023 earnings call. My name is Alyssa and I will be your moderator for today's call. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. If you would like to ask a question, please press star one on your telephone keypad. I would now like to pass the conference over to your host, Chuck Cohn with Nerdy. Mr. Cohn, you may proceed.

Good afternoon, and thank you for joining us for Nerdy's first quarter 2023 earnings call. With me are Chuck Cohn, founder, chairman, and chief executive officer of Nerdy, and Jason Pella, chief financial officer. Before I turn the call over to Chuck, I'll remind everyone that this discussion will contain forward-looking statements, including, but not limited to, expectations with respect to Nerdy's future financial and operating results, strategy, opportunities, plans, and outlook. These forward-looking statements involve significant risks and uncertainties that could cause actual results to differ materially from expected results. Any forward-looking statements are made as of today's date, and NERDI does not undertake or accept any obligation to publicly release any updates or revisions to any forward-looking statements to reflect any change in expectations or any change in events, conditions, or circumstances on which any such statement is based. Please refer to the disclaimers in today's shareholder letter announcing NERDI's first quarter results and the company's filings with the SEC for discussion of the risks. Not all of the financial measures that we will discuss today are prepared in accordance with GAAP. Please refer to today's shareholder letter for reconciliations of these non-GAAP measures. With that, let me turn the call over to Chuck. Chuck?

Thanks, TJ, and thank you to everyone who has joined us today. One year ago, we unveiled an ambitious plan to evolve our products and revenue model toward long-term, recurring, always on relationships with our customers. We created new subscription and recurring revenue products, including learning memberships for consumers and teacher assigned and on-demand products for institutional customers that were built specifically to address the ongoing support we believe both types of customers needed and desired. We shared that we believe these new models would provide a superior platform for innovation by allowing us to bring together multiple different product capabilities we had developed into a comprehensive all access offering that enabled learners to receive the help they need across multiple learning formats, thousands of subjects, and multiple academic calendar years. In addition to allowing us to provide a better and more personalized experience to learners, the new operating model would be far more efficient to operate. allowing us to drive operating leverage, simplify our sales model, and shift additional resources toward net new innovation, including the application of AI for HI or artificial intelligence for human interaction. To get to this evolved state, we shared that this new model would require trading off revenue recognition in the short term because our package model had a more front-loaded revenue recognition than the learning membership model where subscription revenue is recognized linearly over time. We expected that by the start of the second quarter of 2023, the cumulative build of recurring revenue from learning membership customers would cause us to return to growth in our consumer business, as well as for the total company, but now with a product suite and revenue model we believed would position us for higher levels of growth, profitability, and predictability in the years to come. We stated that we expected our new business model to deliver substantial operating efficiencies and that we anticipated achieving adjusted EBITDA profitability by the end of 2023. I am pleased to share that in the first quarter, we exited the J-curve business model transition to subscriptions and returned to year-over-year growth, delivering $49.2 million of revenue, which was above our guidance range of $45 to $47 million. Learning membership subscriptions accounted for 60% of total company-recognized revenue, up from nearly 0% in the first quarter last year, demonstrating strong product market fit. On the institutional side of the business, we delivered record revenue of $8.5 million, an increase of 32% year-over-year, representing 17% of total recognized revenue in the first quarter. In combination, our consumer subscription and institutionally contracted revenue accounted for 77% of total company revenue recognized in the quarter, a dramatic increase over the past year, which we believe speaks to the power of our platform-oriented approach to growth and how we can efficiently go to market with all-access solutions that can provide more value to customers. The rapid business model evolution of learning memberships and recurring revenue and our continued application of AI to the customer experience and operational processes drove continued growth and improvement in customer lifetime values relative to our package model, as well as operating efficiency improvements. Together, they were key contributors to our strong operating results and improved profitability. We are pleased to share that we achieved adjusted EBITDA profitability in the first quarter, nine months earlier than our target of the fourth quarter of 2023, delivering nearly 1,700 basis points of improvement year-over-year, and 1.4 million of adjusted EBITDA. The improvement in adjusted EBITDA represents an annualized improvement of approximately $32 million. We also realized $6.8 million of positive operating cash flow and $5.8 million of free cash flow in the quarter. I'm pleased to share that we made substantial progress on accelerating the use of generative AI throughout our business including launching two new customer-facing products, as well as accelerating the use of AI and machine learning to drive substantial operating efficiencies and internal productivity improvements. As we shared with you in our prospectus two years ago when we made our intention to become a publicly listed company known, we've long believed that AI can fundamentally transform how people learn. We've been applying AI to our business, products, and operational processes for over six years, and AI has been foundational to our ability to improve quality, enhance personalization, and decrease the cost of our offerings. AI powers our ability to identify the highest quality experts, assess learners' foundational knowledge, help ensure the right expert learner match, and drive operational efficiency, among many other use cases. In our prospectus, we also describe the proprietary technology infrastructure we're building as AI for HI, or artificial intelligence for human interaction, and outline the core foundational capabilities we apply to live learning to enhance the interaction in ways that were not previously possible. Through the application of AI, we aim to provide experts and learners with superpowers that transform live online learning. We credit our orientation around AI for HI for allowing us to reach the milestone of having recently delivered our 10 millionth hour of live one-on-one tutoring on our live learning platform. And more broadly, for allowing us to make good on delivering high-quality relationship-based live online learning available at scale. We've used this data and the insights we garner from having instrumented every part of the learning journey to drive real-world practical value in our business. We credit AI for enhancing our customer lifetime values, helping us identify what each student does or doesn't know about a particular subject, when to reach out to a customer to drive engagement and retention, and how to make operational processes far more efficient. We believe we stand to benefit tremendously from the latest advancements in generative AI and further drive revenue growth and cost reduction through its application. What has been maybe most exciting is seeing what our internal teams have been able to accomplish over the last 90 days and the overall pace of innovation internally. As internal access to generative AI tools has expanded, we are seeing it enhance our team's quality of work the speed it takes to complete said work and open up new possibilities for products and process improvement in a way that previously would not have been feasible or that would have been cost prohibitive. To illustrate the speed of innovation, I'll cover some of the progress we've made leveraging AI in just the last quarter. We've continued to improve our expert learner matching algorithms. As a reminder, We first started applying machine learning matching algorithms six plus years ago to begin to detect patterns that no human possibly could to better inform the match between a learner and an expert. And with thousands of experts available for a given learner, taking a technology-first approach to programmatically identifying patterns that were predictive of better learning experiences and outcomes has proven highly effective. Today we simultaneously test competing machine learning algorithms until one is named the statistical victor and flipped to 100% of the volume for a given segment, and then the process repeats. And as we capture and better leverage data to inform the learner-expert match, the quality of the match will continue to improve for both learners and experts, in turn leading to a far better learning experience, ultimately driving better customer satisfaction, better learner outcomes, and ultimately higher customer lifetime value. In the first quarter, we also further expanded learning formats and content. Our growth flywheel, which we first shared publicly in January of 2021, reflects additional learning formats beyond one-to-one as a key contributor to what attracts new learners to the platform. These additional learning formats combine with relevant content to the subject being learned create personalized learning experience that drive engagement and retention of learners on the platform. During the first quarter, we leveraged generative AI to launch two previously announced products, AI-enabled chat tutoring and AI lesson plan generator, both of which we believe will be further accelerants to our growth flywheel. Additionally, we have steadily enhanced the availability of asynchronous content on the platform in areas like self-study and computer-adaptive diagnostic testing which has driven higher levels of engagement and customer satisfaction. However, due to the unlimited possibilities of subject and age complexity and the nuances between school curriculums, it just wasn't feasible nor possible to have rich levels of content in every single subject that someone could conceivably want to learn on the platform. Thanks to advances in generative AI, that has now changed. We stand to be a huge beneficiary of being able to infuse high quality, hyper-personalized content that has historically been expensive and time consuming to develop into every learning experience. We believe this hyper-personalization will allow us to further meet the needs of our learners on a recurring basis over time. We're also seeing significant improvements to productivity and operating efficiency through the application of generative AI. Today, approximately 30% of our software code is being written by AI. All of our employees have access to inline generative AI capabilities like GPT-4 and are encouraged and expected to use it in their work. And we're now using generative AI to more efficiently solve customer support interactions and automate operational processes, including now broadly leveraging AI-powered support bots across learner-facing, expert-facing, and even internally-facing interactions, and we expect to see further wins on driving both conversion and retention, as well as improvements in operational efficiency as a result of continued investments in generative AI across the business. Let's move on to learning memberships, which are scaling ahead of expectations. We continue to see substantial evidence that validates our belief that that the learning membership model leads to more attractive unit level economics longer duration and higher lifetime value customer relationships higher gross margin and a more scalable and efficient operating model. We are also able to provide an improved and more comprehensive learning experience for learners and more consistent earning potential for experts. We remain convinced that this all access, always on business model serves as a better platform for innovation and growth. It allows us to better capture and then apply our proprietary data across product interactions over time to drive deeper personalization for learners across many different learning formats and subjects. And we're able to easily incorporate new products that add more value to the learning membership experience over time. learners have a better experience on the platform, engage more frequently and for longer periods of time, and were ultimately rewarded in the form of higher customer lifetime values. Learning membership revenue continued to grow at a rapid pace during the first quarter and reached an annualized run rate of approximately $143 million as of March 31st, an increase from $87 million as of year end and nearly $0 in the first quarter of 2022. Active members grew to nearly 33,000 as of March 31st, up from approximately 20,000 as of year end. During the first quarter, we expanded learning memberships to new customer audiences by fully transitioning all purchases by existing package customers into learning memberships, as well as moving all of our new test prep audience customers into learning memberships. As we look ahead, we plan to transition the professional audience to learning memberships by the end of the year, which would represent a transition to 100% of new customers to our consumer business to always-on recurring revenue products. This past quarter, we introduced month-to-month learning memberships, which are driving higher levels of conversion by alleviating friction in the member experience while increasing the average monthly subscription fee and accelerating the marketing payback period. We also enhance the value provided in learning memberships by providing unlimited access to two new products. Our AI-enabled chat tutoring enables learners to receive help from an AI tutor and also involve a live human tutor with the click of a button. After piloting this capability in early Q1 and receiving positive feedback and engagement data, we recently expanded access to all learners on the platform. The primary use case so far involves quick Q&A and homework help in between live recurring one-on-one tutoring sessions. It's a good example of how generative AI has enhanced our ability to build a product, in this case, one encompassing Q&A and homework help that historically would have required substantial investments in content, but now can be done for effectively no cost and served up to the customer in line at the right moment in the learning journey to keep them learning efficiently and effectively. The second product we added to learning memberships was our AI lesson plan generator. We went from idea to minimum viable product to a fully built and value added capability deployed across our entire platform and available to all experts as of late April. With this product, we use generative AI to pre-generate lesson plans, including practice problems and other curriculum content in advance of tutoring sessions. The lesson plan generator is embedded in the user interface as a dynamic and editable pane that is ever present during live tutoring sessions. We consider the ability to create hyper-relevant, hyper-personalized content spanning any subject, any age level, that is personalized for the unique needs of the specific learner to be an example of the sort of superpower we have made available to experts and learners that previously would have either been impossible or cost prohibitive. With the addition of these new products, we continue to grow the percentage of learning membership customers engaging in a non-tutoring format during the first quarter to over 27%, the highest of any quarter yet. Multi-format engagement has historically been highly correlated to lifetime value extension. Looking ahead, we're working to make it easier for learners to more fully engage with their learning membership by improving discovery in an all-new member portal. This will include personalized AI-generated learning recommendations that predict and suggest the next product interaction across learning formats and subjects that is most likely to drive engagement and customer value. As we head into the slower summer months, we've created compelling content for learning members to keep learning over the summer through increased engagement with academic, college prep, and enrichment subjects. Turning our attention to our institutional business of Varsity Tutors for Schools, enhancements to our product suite of high-dosage tutoring, teacher-assigned, and on-demand, coupled with prior investments in Varsity Tutors for Schools sales and go-to-market, resulted in record institutional revenue of $8.5 million in the first quarter, an increase of 32% year-over-year, and representing 17% of total revenue in the first quarter. Varsity Tutors for Schools executed a record 97 contracts, totaling $6.3 million of bookings during the first quarter. Varsity Tutors for Schools engagement trends, including our new teacher-assigned products, significantly exceeded our expectations and provide us with confidence that the solutions we have built have strong product market fit and are well suited for meeting the needs of school district partners, teachers, and students, and helping students learn in an unprecedented scale. TeacherAssign continues to deliver against our vision for delivering personalized live learning at district-wide scale while providing unparalleled support and agency for educators. These high levels of engagement are occurring across a wide variety of grade levels and subjects, and teacher feedback has been enthusiastic that they love it. In particular, teachers see teachers assigned as a co-teacher in the classroom, empowering them to help more students. Each teacher's unique insights of individual students, including that student's understanding of the classroom curriculum, are incorporated into tutoring sessions. These strong results and continued momentum to start the year give us increased confidence that Varsity Tutors for Schools is well positioned to provide solutions that administrators, teachers, and students are seeking to support their evolving needs. In closing, live human instruction that inspires and motivates when coupled with AI is enhancing the state of learning. With recent advances in generative AI, the ability to deliver personalized live instruction at scale for all students is within reach. We're proud of our progress to date, growing our learning membership count to 33,000 active members. However, with more than 50 million students in the United States alone, we're just getting started. We look forward to remaining at the forefront of product innovation and enhancing our ability to meet the needs of both consumer and institutional learners. With that, I'll hand the call over to Jason to discuss the financials in more detail. Jason?

Thanks, Chuck, and good afternoon, everyone. I'm pleased to be speaking with you today about another strong quarter for Nerdy. We previously shared that we expected our evolution towards learning memberships would lead to longer duration and higher lifetime value customer relationships, enhance the gross margin, provide for more attractive unit-level economics, and drive higher levels of growth and profitability. I'm pleased to report that during the first quarter, Our team's hard work on the evolution to recurring revenue offerings pulled through, delivering a return to growth and positive adjusted IPTA of $1.4 million, a nearly 1,700 basis point improvement year over year, and more than nine months ahead of our stated target. Looking ahead, we expect to yield additional efficiency improvements through scaling learning memberships, driving additional automation and self-service features, and the continued application of AI throughout our business. Turning to Q1 results. In the first quarter, we delivered revenue of $49.2 million, results that were above our guidance range of $45 to $47 million. These positive results reflect the continued growth in active memberships, which totaled nearly 33,000 as of March 31st, up from 20,000 at year end. Learning memberships revenue grew to $29.7 million during the quarter and represented 60% of consumer revenues in the quarter. up from nearly 0% in the first quarter last year, demonstrating strong product market fit. Our institutional business delivered record revenue of $8.5 million, representing 17% of total revenue during the first quarter, and delivered bookings of $6.3 million. On a combined basis, learning memberships and institutional revenues delivered 77% of total revenue, a substantial change from just two years ago when the business was a 100% package business and 0% institutional revenue business. Moving down to P&L, gross profit of $33.9 million for the first quarter represented an increase of 3% compared to the same period last year. Gross margins of 68.9% for the first quarter were approximately 90 basis points lower than 69.8% in the same period last year. The increase in gross profit was driven by gross margin expansion across our consumer audience which was offset by higher than anticipated engagement with our new products and our institutional business. As we evolve towards a greater mix of learning membership revenue, we expect consumer gross margin to expand throughout 2023. Sales and marketing expenses on a GAAP basis were $15.6 million in the first quarter, a decrease of $7.4 million compared to the same period in 2022. Non-GAAP sales and marketing expenses, excluding non-cash stock-based compensation, were $14.7 million. or 30% of revenue in the first quarter. This compares to 47% of revenue in the same period of last year, and approximately 1,700 basis point improvement year over year. Sales and marketing spend and efficiency improvements were driven by the transition to learning memberships, including the continued expansion of lifetime value, our focus on optimizing the level of marketing spend, and a more efficient operating model in our consumer business. We also delivered substantial Varsity Tutors for Schools revenue growth yielding efficiencies from prior investments in the institutional sales and go-to-market organization. As learning memberships become a greater percentage of total revenue and the institutional business continues to scale, we expect to yield durable sales and marketing improvements. G&A on a GAAP basis was $29.7 million in the first quarter, a decrease of $800,000 compared to the same period in 2022. Non-GAAP G&A expenses excluding non-cash stock-based compensation, were $19.5 million, or 40% of revenue in the first quarter. This compares to 41% of revenue in the same period of last year, and approximately 100 basis point improvement year over year. Combined with our ongoing efforts in automation, self-service capabilities, and the application of AI, we've been able to generate operating efficiencies and remove significant costs from the business. As noted, we reported adjusted EBITDA of $1.4 million, a nearly 1,700 basis point year-over-year improvement in the first quarter, beating the guidance range we provided of an adjusted EBITDA loss of $3 million to break even. Cash provided by operating activities was positive $6.8 million in the first quarter of 2023 compared to cash used in operating activities of $0.9 million in the prior year period. resulting in cash and cash equivalent balances increasing by $5.8 million during the quarter ended March 31st. With no debt and $96.5 million of cash on our balance sheet, we believe Nerdy has ample liquidity to fund the business and pursue growth initiatives. Turning to our business outlook, today we're providing second quarter and updated full year 2023 guidance. We saw positive new customer addition and engagement trends in the first quarter that have continued into April and May and compare favorably to our normal seasonality and internal expectations. For the second quarter and full year, we expect revenue growth will be driven by the continued evolution towards recurring revenue streams, the corresponding build in the number of learning membership subscribers, and higher institutional revenues. Our positive momentum provides us with increased visibility into in confidence in our expectation that we will deliver sequential year-over-year revenue growth each quarter as we move throughout 2023. For the second quarter of 2023, we expect revenue in the range of $45 to $47 million. For the full year 2023, we are raising our revenue targets to $193 to $200 million, representing 21% growth at the midpoint. versus our 2022 revenue of $162.7 million. For the full year, revenue guidance reflects our decision to shift 100% of the consumer business to learning memberships by the end of the year, including the remaining professional audience. Revenue guidance reflects normal summer seasonality, including anticipated lower levels of new customer acquisition, consumption, and learning membership retention during the summer months when K-12 schools and universities are out of session. Additionally, revenue guidance reflects a higher level of high-dosage tutoring program utilization by school districts in the spring semester and a return to the normal seasonal pattern of starting new implementations in the fall when school starts, thus slightly shifting revenue into the first two quarters versus our prior expectation of consistent use throughout the summer. Our adjusted EBITDA guidance for both the second quarter and full year reflects the continuing benefits from our recurring revenue products, which focus on long-term relationships with higher-value customers and improving consumer gross margin profile and operating efficiencies stemming from our continued shift to recurring revenue business models. For the second quarter of 2023, we expect a non-GAAP adjusted EBITDA loss in the range of $3 million to break even. For the full year 2023, we are raising our targets to an adjusted EBITDA loss in the range of $7 million to break even. Full year adjusted EBITDA guidance reflects the impact of normal summer seasonality and higher variable costs in the third quarter as we ramp into the back-to-school selling season followed by a return to positive adjusted EBITDA in the fourth quarter, consistent with prior guidance. Thank you again for your time. And with that, I'll turn the call back over to Chuck.

Thanks, Jason. And thanks again to all of you for joining us today. As always, we appreciate your interest in NERDI and look forward to continuing the dialogue during this exciting time for the company. With that, I'll turn it over to the operator for Q&A. Operator?

We will now begin the question and answer session. If you would like to ask a question, please press star followed by one on your telephone keypad. If for any reason you would like to remove that question, please press star followed by two. Again, to ask a question, press star one. As a reminder, if you are using a speakerphone, please remember to pick up your handset before asking your question. We will pause here briefly as questions are registered. Our first question comes from the line of Ryan McDonald with Needham. Your line is now open.

Hi, Chuck and Jason. Thanks for taking my questions and congrats on a great quarter. Maybe just want to start first on the institutional business. Clearly some really great momentum there with the record number of deals. You know, we'd just like to understand sort of how you foresee the demand environment on the institutional side progressing as we kind of get into the heart of the selling season here in 2Q and 3Q. And then as we look at the total contract value or the value of the deal count, obviously there's down on a sequential basis. Just curious what you're seeing in terms of deal trends in terms of sizing around. you know, number of modules or offerings are being adopted or size of deals in the pipeline. Thanks.

Thanks, Ryan. This is Chuck. We've, you know, as you know, we landed our first teacher assigned contract. The momentum right out of the gate is super strong and the feedback has been really encouraging and engagement was you know, much higher than we anticipated, which is excellent to see, demonstrates strong market fit. And, you know, we can now go out and kind of talk and demonstrate just how powerful live tutoring can be when teachers across the entire school district are empowered to be able to help students at district-wide scale in a way that's highly individualized and takes into account their unique knowledge of that particular student and the curriculum that's being taught in the class. So that was a huge accomplishment there. We obviously had a strong quarter in totality in terms of revenue as well. And as we head into summer and then back to school, what we're seeing is that the pipelines are continuing to grow. These are very large and very lumpy deals and conversations that we're having. So our last teacher assigned contract, as you know, was approximately $5 million per year. as a SAS license that entitles the school district to district-wide tutoring that teachers can prescribe. And so, these conversations involve many different stakeholders. They tend to be oriented around the start of the school year. So, given the kind of magnitude involved, you wouldn't want to kick these off for just a few weeks or a few months because you really want teacher support, teacher buy-in, where we kind of are very focused on making sure the teachers actually understand how to leverage the tools. And so all of that then lends itself to a series of opportunities that would start at the beginning of the school year. So we feel good about the pipeline value that's growing, feel good about the bundled offerings and how together we're able to provide immense value and serve a multitude of district needs. And then as we head into the summer back to school, I think we feel good about how many of the conversations we're having set us up for, you know, significant scale and opportunity this back-to-school season.

Super helpful. Great. Appreciate the comment and commentary there. And then maybe just on the learning memberships, awesome to see the continued progress there. I guess I'd just be curious, as you continue to grow that member count, what you're seeing in terms of, you know, the makeup of those members, whether they were previous or if the learning memberships are sort of bringing net new learners to the platform. Thanks.

Sure. Yeah, we feel, you know, great about the fact that the business has grown, you know, about 63%, I believe, is the number from the fourth quarter to the end of the first quarter. So, great progress there. In totality of the active members, you know, ballpark, 75%. were new to NERDI and about 25% were legacy, you know, folks who've been using us historically in a package model. And, you know, we're seeing an appeal to all audiences. So, you know, there's kind of a good distribution among student ages and we're seeing it, you know, resonate for different like high levels of subject usage and K through five that are a little bit different than middle school or high school or college or beyond. But, you know, in general, this idea of a comprehensive offering with live at the center that is then surrounded by classes and a variety of forms of async content and different modalities engaging, we think really, really resonates here. So, you know, feel great about the progress and the offerings and engagement differ a little bit by age, but, you know, in general, we're seeing it resonate across all audiences and it's just a more efficient go to market. and one that makes it really easy to add additional product capabilities like whether it's an AI tutor or some other form of content like when we integrated Codeverse, we think it's a very easy and effective way that our customers understand to get more value over time.

Yeah, Ryan, the only thing I'd add there, and we mentioned this on our last call, during the first quarter, we transitioned successfully the entire existing customer base within our academic subjects, which we feel really good about. We also transitioned the test prep audience And then in our commentary, we shared that we're accelerating the transition of the professional business given the positive feedback we've seen from customers as it relates to higher conversion, higher engagement, higher retention. And then from a business perspective, it just allows us to drastically simplify the operating structure, which we feel really good about.

Yeah, and during the back-to-school season, we'll have an opportunity to reintroduce learning memberships for customers who have used the package model in the past but currently aren't active.

Excellent. Congrats again on a great quarter. Thanks, Ryan.

Thank you. Our next question comes from the line of Doug Anmuth with JP Morgan. Your line is now open.

Hey, it's Brian Smileycon for Doug. Thanks for taking my questions. I guess just to start on the membership model, can you just talk about the pricing strategy and structure over time? For example, should we expect a tiered strategy as, you know, the membership strategy proliferates over time. And then I guess just on the investment cadence, can you talk about any needs around AI and generative AI holistically going forward? Thank you.

Sure. Thanks, Brian. Good questions. So we started off with a very simple kind of plain vanilla approach to learning memberships where we wanted to just effectively have one tier of offerings that would allow for us to go to market effectively last call it you know may and judas we started leaning into memberships aggressively and initially that was largely just one-on-one tutoring and then over the course of the next couple of months in the fall as you know we started introducing all these additional learning formats that provided more value including live classes and hundreds of subjects every week we have a variety of different asynchronous formats computer adaptive testing we have code verse and video game creation and we started adding in other modalities like the AI tutor and chat based tutoring and you know a couple other things as well and so that then allowed for us to have all these different ingredients or Lego blocks that created a really really compelling offering for our customers that can allow for us to support them over any academic calendar year and across a variety of different subjects and then allowing them to learn how they want, when they want with live as the cornerstone. So, you know, in general, there's different amounts of one-on-one tutoring that you can get with your package. And one of the things that we've experimented with that has driven both conversion and retention was changing up the frequency. So you could appeal to people that are maybe a little bit more academically focused and are very, you know, concentrated in their efforts versus, say, a more casual learner in an area like, foreign languages for adults. And so in totality, we are trying to take each of these underlying products capabilities and then find the content and the frequency that then allow us to really appeal to a given segment. And so we've seen tremendous conversion wins through pulling on that lever here today. And I would expect that we continue to optimize those for given audiences over time. And then, you know, pairing that with your second question, You know, the amazing thing here with generative AI is we are now able to create hyper-personalized content for effectively free for a given learner in a given subject across thousands of subjects and all different levels of complexity. So if you think about live at the center, you know, the superpower we have as a company, high-quality live learning at scale, and then surrounding it with these other forms of content that can drive engagement that are highly additive that we could serve up in real time in line. There's all sorts of different ways that generative AI can allow for you to get the exact right piece of content in the moment that you need it so you can continue on your learning journey. So we've talked about this idea of comprehensive learning destination and our ability to really live up to that vision and fill in any potential content holes that existed just became dramatically easier. So we're super excited about our ability to leverage generative AI to create really comprehensive, really personalized experiences. And we're actually working on it today. We've announced a couple of those products thus far, but we have many more in flight.

Yeah, I would just echo that. We're going to deploy increased levels of capital against AI and engineering headcount in the near term to maintain a lead. We've established a mistake, innovative speed and drive significant cost optimization as we move throughout the rest of this year. We look forward to reporting the results in the coming quarters.

Thank you. Our next question comes from the line of Brett Knoblauch with Kantor Fitzgerald. Your line is now open.

Hi, guys. Thanks for taking my question and congrats on the quarter. I guess, could you maybe just Give us a reminder on how the seasonality of the business is going to work now with the learning membership model and how that might differ from the package model. And I guess as we look at the second quarter, what should we be expecting from a membership count perspective in the change? And also, I guess you talked a bit about the institutional seasonality kind of gearing up for the back to school season and the start of the third quarter. Should we be expecting maybe institutional revenue to sequentially decline in the second quarter before kind of ramping back up in the back half of the year?

Yeah, great question, Brett. Yeah, so consistent with, you know, prior years and seasonality trends, Q2 revenue is going to be lower than Q1. And as we previously discussed, we haven't yet gone through a transition of learning memberships from one school year to the next at scale. So we're being cautious with respect to learning membership retention and new customer acquisition during the summer months. So our Q2 guide reflects typical seasonality, which is the result of a school calendar and consumer purchasing consumption pattern. I think it's important to also acknowledge, you know, the significant pull forward that we've seen from varsity tutors for schools, high dosage tutoring business. We also have a portion of our business that's on the legacy package that we expect to sequentially decline period over period as we enter the summer months. So net-net, we feel good about the anticipated levels of retention that are included in our forecasting guide, but we are cautiously optimistic there. And then from an active learner count, as of June 30, that would infer about 26,000 active members as we move through the summer, which would then re-accelerate into the back-to-school period consistent with historical norms well into the fourth quarter. So we feel good about those trends. that we're seeing, especially given, as Chuck mentioned on the call, the high levels of engagement in new ads in both Q1, April, and through May to date.

Yeah, so as Jason mentioned, we had really strong engagement on the school side. We did a great job on the implementations. And we had previously assumed some of that revenue would kind of be peanut buttered across the first three quarters. We're just now assuming that it's a little more condensed than the first two. But we feel really good about the engagement there and about how it bodes for renewal. cutting us back to school season.

Perfect. And I just want to make sure that I kind of understood you guys a bit correctly on the gross margin decline. So that was largely due to the institutional mix and that being such a large quarter to institutional front because that's maybe not at scale enough where the gross margin is going to be kind of similar to the rest of the business.

Yeah, that's right. So if you dissect the business into two parts, on the consumer side, we saw continued gross margin accretion, especially as we continue to make shifts towards a higher proportion of learning memberships. And then on the varsity tutors for school side, if you remember, our new teacher assigned product provides all access and unlimited support for an entire student population. With the implementation that took place during the first quarter into the second quarter, we saw substantial levels of engagement. which, you know, frankly, we feel great about that there's product markets that they're, you know, but it did compress gross margins, you know, about 150 basis points relative to our expectation during the quarter, although we believe it sets us up strongly for expanding that product to additional school districts on the one hand and driving increased retention over time.

Yeah, I think the important thing to remember is that while the revenue is recognized linearly on some of these VT4S SaaS products, What actually happens from an engagement perspective is the consumption goes up during the school year, particularly, you know, a period like January, February, March, where it's all in the school year. And then as you go into the summer, you actually have lower levels of utilization, higher gross margin. So we think it's a great product overall. And then, as Jason pointed out, the fact that the engagement was so high on this brand new product, you know, it's a really, really encouraging sign for other opportunities out there. And then board of memberships continues to drive significant gross margin accretion.

Perfect. Thanks, guys. Really appreciate it.

Thank you. Our next question comes from the line of Eric Sheridan with Goldman Sachs. Your line is now open.

Thanks so much, and thanks for taking the questions. Maybe two follow-ups on some of the comments that have already been made, just so we better understand. As you move towards the exit velocity this year and the rate of membership you're talking about, Can you just help us unpack a little bit of how we should be thinking about sales and marketing efficiencies not only in this year but as an exit velocity into next year and how you think about either harvesting some of those efficiencies from sales and marketing as you get bigger in memberships versus possibly accelerating membership adoption and investing them back in the business. That would be topic one. And then topic two, you called out deploying capital behind companies AI. Can you help us better understand how much of these investments might be transient in 2023 to reposition the platform for what might be a different steady state or steady state run rate of investments in AI over the long term and any help you can in terms of comparing those two buckets? Thanks so much.

Thanks, Eric. Good questions. So as it relates to sales and marketing efficiency, we drove 1700 bits of sales and marketing efficiency year over year in the first quarter. And the reason we were able to do that was a couple of things. First, we have the new learning memberships model, which is significantly extending lifetime value in the shareholder letter. You can actually see just how much LTV has gone up on average relative to the old package model. But, you know, it's a ton and it's continuing to increase. Secondly, we focused our marketing efforts on appealing to customers who are looking for recurring support over multiple academic subjects, multiple academic calendar years, where we could serve them, you know, in a comprehensive way. And so, you know, by doing so, in effect, you're not focusing on what we previously described as, you know, call it the 7% of hyper-transactional netbookings, and you're really optimizing, you know, for the 93% that we think are the customers that want to be supported with tutoring and a comprehensive set of solutions like we have. Right now, we've been targeting marketing payback periods that are very efficient, you know, call it, you know, six months or less payback periods. And as we get through the summer and see how we're looking on those LTV curves as we head into the school year, there's going to be an opportunity to potentially change that payback period a little bit and see if, you know, we're so excited about the view of economics and have enough data that we can lean in a little bit more aggressively. So the other vector here is not just getting more sales and marketing efficiency, obviously, but rather accelerating growth through changing that payback period a little bit and then acquiring a much larger number of users. So we're actively focused on things that we think will allow for us to do that, not baked into the plan, but we're focused on driving improvements to conversion, making our product more appealing, you know, expanding the amount of content and offerings that are embedded within it, and then separately driving retention over time. And through those two factors, conversion and retention, those are the things that also would allow for us to fundamentally open up the spigot on marketing in a very efficacious way. So I think we feel really good about the model today and the new customer trends. The new customer trends, you know, are pretty consistent throughout the first four and a half months of the year and, you know, are doing well. you know, in April and May, but there's definitely going to be an opportunity as we see some of that data to potentially lean in a little bit further to drive higher levels of revenue growth. And now the second part, yeah, on the capital side, I think the way I think about the deployments in AI, a lot of the infrastructure has been built, a lot of data has been captured, and we've had more than 10 billion hours of live instruction on the platform. Every part of that customer journey is instrumented. The learning itself occurs you know, in a video session on the platform that then has computer-adaptive testing and Q&A and other forms of content that you can engage in, all of which, you know, is kind of captured and fed into our data lake. And so a lot of the work has been done and the plumbing has been built over many years to ensure that we're capturing right information and then can use it to drive higher levels of personalization and engagement. So we have been adding to the team, but, you know, that's relatively modest. in the scheme of things. And thus far, based on what I've seen, it's largely been self-funding. So we would expect to make some investments, you know, in personnel in particular over the course of the next quarter or two. But we're getting, you know, incredible yields on our efforts and would expect that as we get into the fourth quarter and beyond that, you know, it's fully self-funding if not more.

Great. Thanks for the comment. I really appreciate it.

Thank you.

Our next question comes from the line of Andrew Boone with JMP Securities.

Andrew, your line is now open. Moving on to our next question from the line of Mario Liu with Barclays.

Your line is now open.

Great. Thanks, guys. This is Alex Huzon for Mario. Just two quick questions, if I can. On the active expert side, looks like it was down about 10% this past quarter. And you made comments previously that you're focusing on allocating more work to fewer active experts. So just wondering if there's been any incremental changes in terms of how you're identifying and acquiring those experts and if your current AI products or future AI products shifts that philosophy even more. And then second question, just is there any update on the American Rescue Plan dollars being deployed to nerdy services? And if so, what does that look like for the rest of the year? Thanks.

Great questions. And I can take the first one and then hand it over to Jason for the second one. So we have made a conscious effort to focus on acquiring, you know, and retaining top experts who do a disproportionately good job and making sure that they get a great experience in the sense that they're getting kind of consistent earning opportunities over time. So in that regard, learning membership has been terrific for the expert experience because they're meeting with students on a recurring basis, typically call it one to two times a week for the entire semester or school year in pursuit of a goal or skill, and as a result, they're able to count on the earnings associated with that. So one of the things that we've tried to do is rather than more kind of randomly or democratically distribute the different opportunities, we've continued to lean further into our machine learning matching algorithms that then disproportionately send opportunities to top experts. And by doing that, we're then able to retain them longer, which of course then leads to a much better customer experience over time. So there's kind of a compounding flywheel aspect to this. And one of the things that we've also been able to do is also start getting better at predicting who won't be likely to get work on the platform and be as successful and using AI and predictive algorithms to try to predict upfront before somebody even joins the platform, who's likely to be a consistent expert who then drives high levels of customer satisfaction and takes on a number of students versus those that say maybe are a little bit more transient, interested in a short amount of work, smaller amount of work. We'd rather concentrate the relationships a little bit more so you can deliver a better customer experience. Of course, there's costs associated with bringing on experts. So it's terrific for the business to be able to decrease the number of people who might join and not actually work with students. So this is a conscious effort. We feel great about it. and you're seeing it pull through to operating leverage.

Yeah, and then just on your question related to ESSER funding, one thing to keep in mind, unlike the B2B space where companies are pulling down third-party spending, all the government funding for schools has already been provided, the money's in the market, and schools are seeking out our solutions like ours to address the student and teacher shortage that we're seeing in the marketplace. So as of January 31st, only about 28% of the funding has been spent, according to the DOE. And administrators are looking for long-term solutions like ours because learning loss and teacher shortages are long-term issues. We believe our new per-student, per-year programs, like teacher assigned and on-demand, allow for long-term durability as the product offerings evolve to meet both those needs, and support teachers as co-teachers in the classroom in their normal daily workflows. So, substantial amount of money still on the market. still needs to be spent by September of 2024. But even beyond ESSER, because of that support for teachers and their daily workflow, we've got normal operating school budgets, which are all running surpluses. And then beyond that, you've also got Title I funding, which was $19 billion in the most recent omnibus bill. And those funds are evergreen. So we feel like there's plenty of funding in the market to support continued growth in varsity tuition schools.

Yeah, we feel really good about momentum there. And we've obviously evolved our offerings from what had initially just been high dosage tutoring to one that's much more comprehensive and to these new staff models of teacher assigned where the teachers really are at the center of the offering. And we think that's really powerful here. So the fact that schools have been a little bit slower and more discerning in spending and totality, we think bodes well for us because it's given us an opportunity to build this exceptional product that, you know, is highly relevant to the scale. We think we're uniquely qualified to deliver high quality live wording at scale in a way that hasn't been done before through our district partners and really help them accomplish things that might otherwise have been more difficult for them to accomplish as it relates to helping students.

Thank you.

Our next question comes from the line of Andrew Boone with JMP Securities. Your line is now open.

Hi, guys. Thanks for taking my question. This is Matt on for Andrew. Just wanted to ask, with Conmigo being offered for $20 a month, is there something that you guys are going to have to do with pricing or packaging as the competitive side evolves around AI? And then maybe a second one just on institutional, you know, are school districts asking for anything on AI-based tutoring offerings? Or is this something that you guys are looking at on a product roadmap? Any color there would be super helpful. Thank you.

Sure. Okay, good question. So chat-based tutoring has been around for 27 years. And, you know, it's been $20 a month. And we're excited about incorporating it as a modality of offering. But it's one of many, many different ways that you can learn. So as we think about our AI tutor and what it's able to accomplish, it's something that was being used today for called homework help. It's being used for Q&A. And it's kind of taking the place of all these content resources that historically had existed online. What we're seeing is that people are using it to engage additionally beyond their live recurring face-to-face tutoring sessions that are in pursuit of the goal. And so we see it as another form of content creation and another modality of interaction. So, you know, from our perspective, like we're going to be adding all sorts of different ways to engage. And, you know, this is one of them that happens to be in the press a lot and we think, you know, is exciting, but we're applying AI across a wide variety of different forms of both content personalization, expert learner matching, And then also applying it to drive operational efficiencies. And so as we think about schools, I mean, this is a really exciting opportunity. So if you think about all the technology that we've built and our application of AI to drive human interaction and give what we describe as superpowers to tutors and now educators, this is an area where we're actively seeing schools ask about it. And really, how can we allow for their teachers to drive higher levels of personalization in your day? So as an example, the idea of an IEP or individualized education plan has been tossed around for decades as something that, in an ideal world, schools would be able to provide to each and every student. But they can't. They can only do it for a small subset of students. Now, thanks to generative AI, that's the sort of thing where you could actually do it at scale in a way that's hyper-personalized and aligns to both the state standards within a given state and the specific curriculum requirements of a given school, and that would never have been possible. So we're super excited about our ability to take some of the products we're building and then extend them into schools in ways that are kind of wrapped around live and provide additional capabilities to teachers that give them leverage and help educators solve problems.

Thank you, super helpful.

Thank you. There are no additional questions waiting at this time, so I would like to pass the conference back over to the management team for closing remarks.

We'd just like to thank everyone for their time on the call today. As you can tell, we feel really good about the business model transition, the learning memberships, and the expansion of RCTutors for Schools, as well as the application of AI throughout our business to drive continued growth and cost efficiency.

That concludes today's call. Thank you for your participation. You may now disconnect your lines.